A few days back one NRI asked me a very specific question through business Bhaskar. He asked that since the Real estate is a growing investment class and has generated huge returns in past, why in India Financial planners are reluctant to advise on this area. Well, my answer was very short due to the restriction of space, but I am elaborating the answer in this blog post. I believe that this is the concern of many and even I have faced such questions being asked by many of my prospective clients, so I hope this post will answer all of your doubts.A financial Planner’s job is to help clients achieve their long and short term goals comfortably. He prepares a plan which also carries investment advice for allocating the surplus funds in different assets keeping in mind the risk profile, so that the right amount of money should be available at right time to the investor. Real estate and Equity both are growing and volatile asset classes, but still, Real estate especially in India is riskier to invest in, and generally, financial planners find it difficult to map with Goals. Below are some of my thoughts and reasons to it.
1. Lack of Transparency: Real estate is one sector where you can’t get all the information on a single website or in a single document. Moreover, there are many hidden/unclear things in a project which makes the deal riskier. Few of them are material information on Promoters, past project delivery experience, the status of the land, Statutory approvals, etc. Usage of different ambiguous terms like Carpet area, super area, etc., restricts informed decision making. Also in case of Resale transactions sometimes establishing ownership is very difficult due to the lack or availability of clear land titles. Such things have made this sector very opaque and thus resulted in widespread disputes and litigation.
2. High Transaction Cost: Brokers charge 1-2% of transaction cost, Stamp duty ranges from 5% – 8% depending on the state where the property lies in. If you are constructing your property then you also will have to bear the inflation cost which will hit the construction material, architects fees, contractor charges and also fees towards taking various approvals like for electricity connection, water connection, etc. All these increase your cost of purchase and if not planned properly will hit your cash flows and surely the goal achievement.
3. Taxability: Any gain in real estate is taxable. Though tax rates vary for the short-term and long term and the investor will also get indexation benefit for long-term transactions but still, he has to pay 20% tax on Indexed gains which reduces the overall net returns out of real estate. ( Read: How indexation helps in saving capital gains Tax)
4. Menace of Black Income: High Transaction cost and Taxability both have led to increasing in tax evasion with the parties involved understate the property sale and purchase prices. Even if buyer wants to pay the price in white (by cheque) seller wants to receive the money in cash so he can avoid paying some capital gain taxes. Sometimes even buyer wants to pay in cash so the registration cost should be at the minimum required by law. This creates a vicious circle as black income generates more black income which can go nowhere but in real estate only.
5. Low Liquidity: Real estate can’t be sold with a click of a mouse. Many times you don’t find a buyer, even if you want to sell below the purchase price i.e in the loss. If the property has been mapped with a goal then in this situation complete financial planning can go for a toss. Keeping this in mind financial planners avoid mapping real estate with a certain time-framed goal.
6. No partial withdrawal provision: You cannot sell your real estate partially like a room of a flat or some portion of your built-up property. You may find yourself in a big financial soup if you have not planned your cash flow properly and also are over-invested in real estate.
7. High maintenance cost: You have to pay a price for keeping the property in a resaleable state. Even if you don’t live in it or don’t give it on rent, you still have to pay the cost for maintaining that property in the form of society charges, minimum electricity charges, Renovation charges, improvement charges, etc. Now many states have started levying Property taxes also.
8. Low rental Yield: Placing the property on Rental and earn a regular income is one of the main reasons for buying property by many. Many people give it an excuse that they will not lose money on maintenance costs as they will keep the property on rent and see the capital value growing. But mathematically people lose on this front too. Rental yield especially in Residential property in India is very low. Its hardly between 1%-3% and that too is taxable. I have already pointed out the taxability, Black income menace on capital gain value. If one calculates all the costs and taxes out of the property income then the Net returns are not worth making so many efforts.
9. No ready market: Unlike other asset classes like equity, gold, and debt, real estate does not have any ready market available where people sell or purchase on a real-time basis. The process is long and that too starts only if buyer and seller are available and agreeing to the transaction. The price discovery mechanism is also very opaque in this sector.
10. No Regulator: Unlike the Stock market where is SEBI, banking where is RBI, Insurance where is IRDA real estate sector does not have any regulator. This means there’s no one to keep a watch on what builders, real estate companies, and agents are doing and thus no one to protect the interest of consumers. Increasing the prices by quoting less, not delivering the project on time, Charging for services which was earlier termed as free etc. are very common things these days. The plight of residents of the Campa cola complex in Mumbai is also the result of having no regulator over builders and a nexus between builders and corrupt politicians. We hope that the Real estate (Regulation and Development) bill which is still pending in parliament will bring the necessary transparency in this sector.
I wonder how and why in India people treat Real estate as safe and equity as a risky asset class that is devoid of all the above-mentioned issues. Equities are much transparent, cost, and tax-effective, properly regulated, liquid asset class. When investors expect trust, transparency, and wise advice from Financial Planner, how can he expect a planner to advise on putting their hard-earned money in such an opaque sector.(Read: Is your investment adviser Registered with SEBI?) Real estate can surely give you a high and a sense of pride in ownership of a tangible asset but as an investment, it has a lot of flaws in it.
With the coming up of regulators and also Real estate investment trusts (REITs), going forward investments in this sector may become advisable, but till then Beware of the risks and costs involved. As warren buffet said, “Risk comes from not knowing what you are doing”. If you think that even after understanding the risks you feel safe in real estate, then it’s purely your choice.
Do share your views and experiences on Real estate Investments.